奇波雷墨西哥燒烤 (CMG) 2013 Q3 法說會逐字稿

Good afternoon and welcome to the Chipotle Mexican Grill third-quarter 2013 earnings conference call.

All participants are now in a listen-only mode.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

As a reminder this conference is being recorded.

I would now like to introduce Chipotle's Director of Investor Relations, Alex Spong.

You may begin.

Thanks, Amber.

Hello, everyone, and welcome to our call today.

By now you should have access to our earnings announcement released this afternoon for the third-quarter 2013.

It may also be found on our website at chipotle.com in the Investor Relations section.

Before we begin our presentation, I will remind everyone that parts of our discussion today will include forward-looking statements as defined in the securities laws.

These forward-looking statements will include projections of the number of restaurants we intend to open; comp restaurant sales increases; potential menu price increases; trend and food costs; marketing spend; G&A and other expense items; effective tax rates; stock repurchases and shareholder returns as well as other statements of our expectations and plans.

These statements are based on information available to us today and we are not assuming any obligation to update them (technical difficulty).

Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements.

We refer you to the Risk Factors in the Annual Report on Form 10-K as updated in our subsequent Form 10-Qs for a discussion of these risks.

Our discussion today will include non-GAAP financial measures, a reconciliation of which can be found on the presentation page of the Investor Relations section of our website.

I would like to remind everyone that we have adopted a self-imposed quite period restricting communications with investors during that period.

The quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings conference call.

For the fourth quarter it will begin in January and continue through our fourth-quarter release.

On the call with us today are Steve Ells, our Chairman and Co-chief Executive Officer, Monty Moran, Co-chief Executive Officer, and Jack Hartung, Chief Financial Officer.

With that I will turn the call over to Steve.

Thanks, Alex.

I am pleased with our results for the third quarter and the continued strength of our business throughout the year.

During the quarter, we generated revenue of $826.9 million, an increase of 18% from the third quarter of 2012.

Comparable restaurant sales grew by 6.2% in the quarter and diluted earnings per share increased 17.2% to $2.66.

These results are the product of our combined focus of our special food and our special people cultures.

This focus is helping us realize our vision of changing the way people think about and eat fast food.

Throughout the quarter, we continued to make progress in each of these areas.

We introduced more customers to the new menu item, Sofritas; expanding our catering program; continued our quest to remove GMOs from our food; developed more restaurateurs and field leaders; brought our field leadership together for a conference to share thoughts on how they might become more successful; and continue to nurture the seeds we have planted for our future growth.

During the quarter, we expanded the rollout of Sofritas, the vegan option we have been testing in our West Coast restaurants.

And that is now available in all of our restaurants in California, Oregon, Washington, Colorado, New Mexico, Idaho and Utah, or about 25% of the restaurants overall.

Recall that Sofritas is an organic artisan tofu that is braised with chipotle peppers, roasted poblanos and a blend of aromatic herbs and spices.

We are encouraged by what we are seeing with Sofritas so far.

It currently accounts for over 4% of sales in the restaurants where it is offered.

And our customers including vegans, vegetarians, and meat eaters alike really seem to enjoy its complex and bold flavors.

In developing Sofritas, our aim was to create a menu item that would offer additional -- offer another delicious option for our vegan and vegetarian customers that would also appeal to meat eaters who might want an occasional meat-free option and that would fit into our service line and not burden our operations or throughput.

So far, we are seeing success in each of these areas as about 50% of Sofritas sales seem to be coming from vegan and vegetarian customers and about 50% coming from customers who are substituting Sofritas for one of our meat options.

Our Chicago, Baltimore, Philadelphia, Richmond, and Washington, DC, restaurants will begin testing Sofritas on October 21.

And by the end of the year, we plan on having over 650 restaurants serving Sofritas or about 40% of our total restaurants.

Another change we are making that will appeal to vegan and vegetarian customers is the removal of bacon from our pinto beans.

From the beginning, our pinto bean recipe included a small amount of bacon.

In testing some different recipes for pinto beans, we have determined that the bacon was not adding to the flavor in a meaningful way and that removing the bacon would not negatively impact the taste of our pinto beans.

In fact, we notice that the smoky background notes come mainly from the addition of chipotle peppers and not the bacon.

By removing the bacon, we are widening the appeal of pinto beans to even more customers, including those who may have other dietary restrictions.

And I am pleased to report that we have already phased the new bacon-free pinto bean recipe into all of our restaurants.

Our efforts to replace GMOs in our food with non-GMO ingredients is an important focus for us in our ongoing quest to improve the quality of our ingredients.

There is considerable debate right now about the environmental, health, and economic implications of GMOs in food.

And more than 60 countries have restricted or prohibited certain GMO foods.

Given the lack of consensus regarding the impact of GMOs, we feel that it is best not to use them in our food.

In March, Chipotle became the first national restaurant company to voluntarily disclose the presence of GMOs in the ingredients we use in our restaurants.

And while these and other GMO ingredients can be found in food in virtually all national restaurant companies, we have been working quickly to remove non-GMO -- working quickly to move to non-GMO alternatives.

We are also making progress in our marketing efforts to help get customers thinking about where their food comes from and how it is prepared.

During the quarter, we hosted our Cultivate Festivals in both Denver and Chicago, following the San Francisco event earlier this year.

In all, these festivals drew over 100,000 attendees who came to enjoy live music, celebrity chef demos, and to learn more about the food Chipotle serves and how it is prepared.

Each event includes a number of important Chipotle experiences where attendees can learn more about our ingredients; the elimination of antibiotics and added hormones; alternatives to processed foods and more.

Visiting four or more of the experiences earned attendees a free burrito at Chipotle.

Additionally, the advertising and PR outreach surrounding the events has shown to have a strong positive impact on the perception of Chipotle, even for people who only see the advertising or PR and do not actually attend the event.

During the quarter we also released an animated film and an arcade style game called The Scarecrow.

The film immediately went viral across Facebook, Twitter, and YouTube.

Since its release, the film has been viewed more than 7 million times online and the games have been downloaded more than 0.5 million times.

We supported the game with a small online and mobile advertising campaign along with a PR outreach, which has generated more than 0.5 billion media impressions so far.

In making The Scarecrow, our aim was to generate curiosity about where food comes from and how it is prepared.

The film is set in a future world where all food is produced and processed by the fictional company, Crow Foods.

The film also depicts the length that Crow Foods goes to in order to obscure the truth from unsuspecting customers.

The film is a cautionary tale about the future we may all encounter unless we commit to producing affordable, healthful food in more sustainable ways.

Ultimately, our aim in making the film was to spark conversation about these issues and that has certainly happened since the film was released.

To help keep Chipotle top of mind with customers, we have continued to run our skillfully made advertising campaign in Chipotle markets around the country.

Results of this advertising are encouraging as the campaign appears to be resonating with consumers.

During the course of the campaign, we saw noticeable sales lifts in sales comps and average daily sales compared to our non-advertising markets.

Other wave of this campaign began in August in proven and mature markets and will continue through October.

Finally, in the quarter we opened a third ShopHouse, this one in Washington, DC's Georgetown neighborhood.

We will open several more ShopHouse locations all in the Washington, DC, and Los Angeles areas over the next 12 months or so.

We also opened our first Chipotle in Frankfurt, Germany, bringing our total number of international restaurants to 14.

We continue to view both ShopHouse and our international expansion as future growth opportunities, rather than near-term drivers of our growth.

And we will continue to carefully support these growth seeds as we develop them for long-term success.

ShopHouse is the first test of our belief that Chipotle success is not dependent on serving burritos and tacos, but rather is rooted in our commitment to finding the very best ingredients, preparing them using classical cooking techniques, welcoming our customers into a space that is thoughtful and that says something about the food we serve, and developing teams of top performers that are empowered to achieve high standards and create a welcoming customer experience.

Our restaurant in Germany open in September and we are encouraged by its strong performance in the first few weeks of operation.

But I would remind you that opening Chipotle restaurants in the US will continue to be the primary driver of our growth for the foreseeable future.

I will now turn the call over to Monty.

Thank you, Steve.

To advance our objective of developing restaurant cultures with teams of all top performers who are empowered to achieve high standards, we held a field leadership conference in Las Vegas last month.

Our aim in hosting this meeting was to bring together all of our field leaders, restaurateurs, apprentice team leaders, area managers, team leaders, team directors, and regional directors to lay out very clear expectations about their priorities and to provide them with tools to help them with the most vital aspects of their jobs, which is developing restaurateurs and restaurateur cultures.

To help better prepare our field leaders to do this, we clearly laid out expectations for them in terms of how to best use their time in the restaurants.

We shared new tools with them to help them identify and diagnose opportunities in their restaurants, and we conveyed thoughts on how they can dedicate themselves fully to developing teams of top performers and power to achieve high standards.

We continued to make progress in developing and expanding our restaurateur program by developing 28 new restaurateurs in the quarter, which now gives us a total of 409 restaurateurs, 40 apprentice team leaders, as well as 47 team leaders.

But I know we can do much better and I am confident that we will, over the next year, because our field leadership structure is better staffed, the tools we provided at the conference are the best and most impactful we have ever had and we experienced the incredible energy and commitment of our field leaders at the conference and as they were leaving the conference to go back to their patches.

So while I am happy with our current development of restaurateur cultures in our restaurants, I do expect to see a significant uptick over the next few quarters in terms of restaurateur development.

We also talked at our conference about the importance of leading our teams to provide great throughput, since this is key to providing a great customer experience and driving our unit economic model.

During the quarter we made strong progress in delivering faster throughput in our restaurants at the busiest times of the day.

In the third quarter, we saw our throughput increase by an average of about five transactions during the peak lunch hour rush and our lunch comp has just about caught up to our all-day comp.

This is on top of last year's increase of four transactions during lunch.

In addition, our throughput also improved during the dinner rush between 6 and 7 PM by four transactions in the third quarter.

We expect to see further improvement to these already high levels as we continue to emphasize and teach the four pillars of throughput to our crews and to our field leaders.

While you have heard me talk about these four pillars for some time now, we still have a significant opportunity to execute them consistently, which we know is going to lead to even faster throughput.

And we now have better tools in place to identify exactly where our greatest throughput opportunities lie.

For example, you have heard me say that of the four pillars, the expediter is the most important because this person speeds up the slowest part of our line, which is the cash register.

Our new tools demonstrate the incredible opportunity as it shows that we are deploying an expediter in our restaurants during the lunch peak hour only 65% of the time.

In other words, 35% of the time that person is not in place.

If they were in place we would go even faster.

Having a linebacker in place is also critical during the lunch rush to ensure that the frontline has great communication with the kitchen.

That food is flowing smoothly from the kitchen to the line and that the line staff can focus 100% of their attention on the customer at all times to provide a great and speedy customer experience.

But again, while it is critical to have this position for fast throughput, our new tools show us that we have this dedicated linebacker in place only 73% of the time.

We also know that some of our markets are showing very strong dedication to the four pillars.

For example, our Team Director [Stephen Hart] on the West Coast has a dedicated linebacker in his restaurants 96% of the time at lunch and Laura Martinez and Travis Moe both the directors in the Central region had dedicated linebackers about 80% of the time.

This has led to them having very impressive gains in speed of service.

All of our field leaders know the importance of consistently executing the four throughput pillars.

But now we have tools in place so that they know exactly which markets and which specific restaurants need their attention.

And we have this kind of performance information for each of the four pillars and for every one of our restaurants.

Given the improved strength of our field leadership team, we know that we will improve even more in this regard in the coming months and that with these improvements our guest experience will be even better.

Another significant accomplishment at our field leadership conference was the rollout of a new tool that helps our field leaders write specific plans to help their general managers become restaurateurs more quickly.

Using this tool, our field leaders will provide quarterly plans for every single general manager in the Company which, we believe, will improve our ability to devote more restaurateur cultures throughout the Company more quickly.

The tool asks field leaders to use the symptoms that they see in the restaurant to identify themes that, once corrected, will allow our general managers to create a more empowering culture in their restaurants and, ultimately, a restaurateur culture.

Let me now give you an update on the catering program we launched in January and how we are expanding our ability to bring this full experience to more people outside of our restaurants.

On October 7 we rolled catering out to 17 more markets, serving an additional 460 restaurants.

The next week, on October 21, we are going to roll catering out to all of the remaining restaurants in the United States with the exception of New York City which is going to be rolled out in 2014.

We remain encouraged by the performance of our catering program.

Overall, for restaurants that are offering catering, we are already seeing catering sales approach 1% of total sales with most of this being incremental.

We will also be starting our first national catering promotion in mid-November in time for the holiday party season.

We believe catering is off to a promising start and showing great potential as we continue to roll this program out across the country and as more customers have an opportunity to try it out.

During the third quarter, we opened 37 new restaurants for a total of 129 restaurants year to date.

Total Companywide restaurants totaled 1,539 at the end of the third quarter, which includes three ShopHouses, six restaurants in London, five in Toronto, and one each in Vancouver, Paris, and Frankfurt.

Based on our year-to-date openings and our scheduled openings for the balance of the year, we are confident that we will meet or exceed the high end of our guidance range of between 165 and 180 new restaurant openings.

I am pleased to report that our real estate pipeline continues to look very solid right now and we can now announce that we expect to open between 180 and 195 new restaurants in 2014, which gives us confidence that we can continue with strong unit growth next year and beyond.

I would like to now turn the call over to Jack Hartung.

Thanks, Monty.

We are pleased with the strength of the underlying business trends during the third quarter, despite operating in a very competitive industry.

And with mixed signals about the strength of consumer demand, we continue to show improved traffic as more and more people chose to visit our restaurants.

Our top-performing crews and management teams continue to delight new and existing customers by providing an exceptional dining experience to our customers during each and every visit.

Our same-store sales were up 6.2% in the third quarter and our average sales volume for restaurants that have been opened for at least 12 months is $2,140,000, the highest it has ever been.

Overall sales for the quarter increased 18% to $826.9 million driven by new restaurant openings and a comp of 6.2%.

Year-to-date sales were $2.37 billion, an increase of 16.7%.

The quarter and year-to-date comp increase was driven by increased customer visits.

We are pleased to see our underlying transaction accelerate sequentially during the year from an underlying comp of 3% in the first quarter to an effective 4.5% comp in Q2 to 6.2% comp we saw in the third quarter.

Our improving sales trends are benefiting from the greater awareness we believe we are achieving with our marketing campaign, as Steve talked about, as well as from faster throughput, as Monty mentioned.

Our comps accelerating around the end of July or beginning of August and continued at that higher level through September and now into October.

Assuming these trends continue through the rest of the year, we would expect Q4 comps will be similar or slightly better than what we saw in Q3.

As a result of these stronger trends, we are raising our full-year sales comp guidance for 2013 to mid single digits up from our previous guidance of low to mid single digits.

As we look to 2014, we expect comps in the low single digit range, excluding the impact of any future menu price increase.

And I will talk about how we are currently thinking about menu prices a little later.

We expect to end the year with total new restaurant openings at or above the high end of 165 to 180 opening range; and in 2014 in light of our strong real estate pipeline, we expect to increase our new restaurant openings to a range of 180 to 195 new restaurants.

And our new restaurants continue to perform very well and as a result we now expect opening sales volumes in the $1.6 million to $1.7 million range, up from our previous expected range of $1.5 million to $1.6 million.

These new restaurant openings volumes along with our current comp trends and strong margins allow us to deliver industry-leading unit economics and returns for both our new and existing restaurants.

Diluted earnings per share for the quarter was $2.66, an increase of 17.2%.

Our operating margins were down 20 basis points to 16.6%, while restaurant level margins were down 60 basis points to 26.8% compared to last year as higher food and other operating cost more than offset sales leverage in the labor and occupancy lines.

Year-to-date diluted earnings per share was $7.93, an increase of 16.7% over last year.

Restaurant level margins year to date were 26.9%, a decrease of 110 basis points primarily due to higher food costs as labor leverage was offset by the higher -- other operating costs.

Food costs were 33.6% in the quarter, up 50 basis points from Q2, primarily related to the higher cost of California avocados which, as we mentioned on our last call, have been challenging from a supply standpoint and therefore are more costly.

To a lesser extent, our tomato salsa costs also increased a bit in the quarter due to adverse weather on the East Coast, causing us to incur higher shipping costs to some of our East Coast markets as we were forced to source from other distant suppliers.

Our tomatoes on the East Coast will continue to cost more until next month when tomatoes will begin to be harvested from nearby Florida.

Compared to Q3 last year, our food cost was up 90 basis points due to higher prices for all of our salsa ingredients, our tomatoes, corn and tomatillos, as well as higher costs for dairy and chicken.

We are also beginning to see higher oil costs as we convert from GMO soy oil to non-GMO sunflower and rice bran oil.

On a sequential basis going forward, we expect our food cost to remain in this 33.5% to 34% range for the next few quarters or so as we expect continued pressure from avocados, and suppliers in Mexico are expecting near-term supply constraints, which combined with rising demand for avocados will keep the cost at an elevated level.

And we hope that inflation on the rest of our produce and our meats will be relatively tame.

As a result of this elevated food cost level, and with expectations of making additional investments in moving to non-GMO ingredients for all of our food by sometime next year, we expect to raise prices sometime in 2014.

And while the timing is difficult to predict as we still have work to do to remove GMOs from our ingredients, a price increase around midyear is a reasonable assumption.

Labor costs were 22.8% of sales in the quarter, a decrease of 40 basis points from last year, driven by the higher sales comps.

Labor leverage was a little better than we might normally expect as our average crew labor rates were similar to last year as we were able to offset higher wages from inflation with lower overtime as a result of better staffing levels at the restaurants.

Year-to-date labor costs were also down 40 basis points and we expect labor costs as a percent of sales will move higher than fourth quarter due to seasonally lower sales.

Other operating costs were 10.8% for the quarter, an increase of 30 basis points, and year-to-date other operating costs were 10.6%, up 40 basis points from last year.

In the quarter, other operating costs moved higher primarily from higher marking costs, which were 1.55% in the quarter up 15 basis points from last year, and year to date were 1.4% or up 30 basis points from last year.

We expect marketing to be at a similar level in the fourth quarter and to step up to around 1.7% in 2014.

G&A was 6.4% in the quarter, 50 basis points lower than last year.

And remember that last September we held our third biannual all manager conference which will also occur in 2014.

The conference costs about $5.5 million in 2012 and will cost an estimated $7.5 million to $8 million next year as we expect about 2,300 managers and support staff to attend.

The decrease from the all manager conference held in 2012 was partially offset by higher legal costs.

G&A includes non-cash, non-economic stock comp expense of nearly $16 million in the quarter and nearly $50 million for the year so far.

And we continue to expect non-cash stock comp for the full year to be around $66 million.

Our annual Boorito promotion and fundraising event will add about $1 million in G&A in the fourth quarter, which will benefit the Chipotle Cultivate Foundation.

In 2014 we expect to manage our underlying G&A to grow at a slower rate than sales before considering the impact of the all manager conference and before any increase in the non-cash stock comp.

Of course, the stock comp next year will depend on the stock price at the time of grant and the number of options issued, but if a similar number of options were granted next year, with the [stock] price equal to about the current stock price, the accounting charge for non-cash stock comp would be about $75 million compared to about $66 million this year.

We expect our effective tax rate for 2013 to be 38.9%.

In 2014 the tax rate will rise to about 39.9%, without the benefit from the work opportunity tax credit and the R&D tax credit.

If these credits are renewed by Congress for 2014 our rate will be lower by about 50 basis points.

During the quarter, we repurchased about $17 million worth of our stock or over 41,000 shares at an average share price of $402.

At the end of the third quarter, we still had nearly $103 million left on our share buyback program previously approved by our Board.

And over the last five years we have invested nearly $600 million to purchase about 4 million shares, and overall average price of $148 per share.

We finished the third quarter with over $835 million in cash and investments with no debt on the balance sheet and we continue to believe that the best use of our cash is to invest in our high returning restaurants and we will continue to plant seeds for future growth including ShopHouse and Chipotle outside the US.

In the meantime we will continue to opportunistically repurchase our stock to enhance shareholder value.

Thanks for your time today.

At this time we would be happy to answer any questions you may have.

Operator, please open the lines.

(Operator Instructions).

Matthew DiFrisco, Lazard Capital.

I was curious about the international strategy and the success that you are speaking of as far as the volumes in the US.

Can you speak about the volumes that you are seeing internationally in respective markets and what that might mean for growth in 2014 and beyond as far as more meaningful growth potentially?

Yes, I would still expect over the next year or so that international won't be a very large part of our growth.

We are still in the brand building phase.

There's still -- the vast majority of people in the markets we are in and outside the US are not yet aware of Chipotle.

We are seeing nice growth trends in restaurants that we have open.

Most of the restaurants that we have opened in London, for example, have gone comp.

And the comps, we are very pleased with the comps.

But the awareness level is still very low.

People are still [checking] us out.

And so I would expect to not see the number of restaurants be a meaningful part of our growth.

And in terms of sales, the sales are, when you convert to dollars, are attractive.

I would call them in the same ballpark.

We are a similar level to what we are seeing in the US.

But because costs are much higher, we are in major cities there.

The rents are higher, there are social costs that are higher as well.

So that as awareness builds, we expect those volumes will grow over time to a much more significant level than our averages in the US.

And then ShopHouse as well?

Are they seeing similar type volumes or is it too early to tell in the LA market?

I think it is too early to talk about the volumes of ShopHouse.

I would say, though, we are really focused on building a great in-store experience and introducing a new kind of Asian cuisine than most fast food customers are accustomed to.

And if I compared teaching them about this new kind of cuisine and the ordering system, it is much the same as it was at Chipotle 20 years ago.

I would say though that it is going a lot faster.

Our growth at ShopHouse is much faster than Chipotle was in the early days.

But really now, we are just building better awareness and improving on the customer experience and introducing people to a new kind of Asian cuisine.

And if we do this all very well, I think we will be preparing ourselves for future growth potential, which is really what it is all about.

Excellent.

Thank you very much.

Jason West, Deutsche Bank.

Thanks.

A question around the pricing.

Can you talk about magnitude, what that might be?

And the timing, I think you said midyear, what would skew your thinking there earlier or later in the year?

Yes, Jason, we are not going to make a decision today on pricing, but I think that it is probably in a mid single digit range.

Whether that is a 3%, 4%, 5%, what it will depend on is what happens with general ingredient inflation between now and then.

And then what it costs us to remove GMOs from the rest of our ingredients.

Once we have all that information at hand, we will be able to do a better job at figuring out what that price increase might be.

And in terms of timing, it is really hinging more on removing GMOs.

We would really like to make more progress, understand what that is going to cost, and how much time that is going to take, all that kind of stuff.

And then we'll feel better about coordinating a price increase around the time that we are moving GMOs.

And we think that there might be a PR opportunity as well.

We think it will be a pretty exciting time for us when we can announce that.

We are not aware of any other restaurant company anywhere near our size that is even attempting to do this.

And so to actually accomplish it will be pretty exciting and we would like to time that excitement around with the price increase.

That's helpful.

And one other one on that throughput opportunity, Monty, you talked about some nice lifts in the peak lunch period.

I think five transactions per hour.

Can you remind us what the sensitivity is to comps for say each transaction for our improvement that you see on throughput?

And how that flows through comps?

Yes, Jason.

It just -- it really, really depends store by store.

I mean, we generally say that there isn't a direct tie to comps in the sense that, if you have a certain amount of people in line at lunch and you go faster, you might serve them from the 12 to 1 hour as opposed to the 1 to 2 hour.

So in various quarters in the past, you have heard me say that at times we have had an increase in the comps sales or actually the -- or comp transactions in the peak lunch hour only to lose a few in the 1 to 2 o'clock hour, sort of cannibalizing from ourselves.

That kind of thing.

So, initially, speeding up throughput does not automatically generate a comp unless it is done in a restaurant where people are walking away from the back of the line and a shorter line would have kept them.

But that being said, we do see, over time, a really nice correlation between our ability to continue to move faster and customers' willingness to come to Chipotle, willingness to wait in line and so forth.

So there is no formulaic way to measure that, but we have absolute confidence that it is one of the key drivers of our success.

It is one of the key ways in which we distinguish ourselves from competitors because we are so much faster.

It is really a huge advantage to us and it is just such a critical part of giving a great customer experience to our customers most of whom would report that the only thing negative about Chipotle is the need to wait in line.

So we were able to improve substantially at the peak hour of lunch and substantially the peak hour of dinner, which makes us really, really proud and also we had faster comp transactions at absolutely every single hour of the day as well.

So, we are really pleased.

We are incredibly thankful to all of our teams in the field for generating that kind of throughput improvement, which is really one of the most substantial we have achieved in any quarter, I think in our history, in terms of absolute numbers.

Okay, got it.

Thanks a lot.

John Glass, Morgan Stanley.

Thanks.

First, could you talk a little bit about the ad lift you are getting in the ad spending?

In other words, you cited some specific statistics where when you were on either air or advertising, I am not certain what you were referring to, you had a discernible lift.

Could you talk about how great that lift was, how sustained it was and can you also tie that into what are you figuring your final ad spend will run this year in total?

Yes, John.

We had rather not parse out the components of the comp.

Over time we believe that if we just do a better job of hiring great people, empowering great people, great restaurateur cultures in our restaurants and then communicate well with our people, communicate this message about where our food comes from and that we really have skill and we use classic cooking techniques with these higher quality ingredients and we can do that with our ads in an authentic way.

Because when our customers come into our restaurants they actually see that we are cooking and they can see the ingredients and we think all of that adds up to creating a great experience, creating this feeling that people have where they trust and they enjoy coming to Chipotle.

Steve had mentioned that we did see -- we don't often see this because a lot of our marketing is more about educating and encouraging people to be more curious about where their food comes from, but we did see in markets where we did advertise compared to markets that we didn't advertise that we saw a lift and it was a meaningful lift.

But in terms of saying how much of that was in the comp, we had rather not say.

I would say in general, though, we believe going forward, we believe that in the past and going forward, the vast majority of our comp is based on creating a great restaurant experience that the marketing should complement that.

It should be authentic to what the actual experience is, but we believe the vast majority of our comp will always be based on having wonderful people creating a wonderful dining experience.

And two other follow-ups.

One is on, Jack, do you have a view yet on food inflation next year and is it going to be the kind of thing where your pricing will be fully used to offset that or only partially, give a view of generally on the basket for next year?

Yes, I would not say our crystal ball is great, John.

I don't see anything that looks terribly troubling.

So I -- we would hope that we would stay in this 33.5% to 34% range, not counting the extra cost related to removing the remaining GMOs.

So if it stays in that range, I would call that pretty tame.

I mean, that would mean from here we would be looking at a 1% to 2% inflation.

And so if things don't change, if weather doesn't -- if extreme weather doesn't change things, we think that our food costs should not rise very much.

Then in terms of the menu price increase, talking about this kind of mid single digits, we think that should be more than adequate to cover the inflation that we have seen so far as well as hopefully absorb the costs of removing GMOs as well.

Hopefully, there will be some left over to -- and we expect there would be some left over to improve our margins as well.

And one final question, Steve, you mentioned in your comments about ShopHouses, one other example of how you can extend the platform of Chipotle into other brands.

What would the timing be?

I presume that means you are the third and the fourth, correct me if I am wrong, and if that is the case how do you think about the right time to introduce those seed concepts to give them time to grow?

Do you mean grow the existing ones, John?

No, I mean like have a third concept beside the first two you have and a fourth because you need time to let them expand so they become meaningful.

I am just getting a sense of if that is something eminent or something that is very long term that you think about any time in the next few years.

Sure, well, if I think about the last 20 years, I mean, the vast majority was spent building the Chipotle brand, really, really showing that there is a better fast food model.

I mean we wrote -- rewrote the fast food rules by introducing high-quality ingredients and interactive service format and this concept of having empowered teams who are really top-performing to deliver a different kind of experience.

It takes a long time and we are really perfected -- or are perfecting this model and just a couple of years ago thought it was prudent to explore a different kind of cuisine.

I think that if you could envision many different kinds of cuisines fitting into this model, it is potentially the new fast food model.

And while it would be exciting to open a bunch of different brands now, I think there's really an importance that we have learned at Chipotle of focus, on focusing on just doing a few things and doing them very, very well.

Once you have done them very, very well and are confident things are moving forward nicely, then you can layer on additional projects and challenges.

So, we feel that we have got a really good pace going now with introducing the ShopHouse brand.

We are really pleased with the results.

I was in the Washington, DC ShopHouses two weeks ago and sitting down and talking to customers.

And the kinds of things that I heard coming from them were just music to my ears which was, this food feels so good.

I love the way it tastes.

It is the kind of food that I want to come eat often.

And it is this creating the dining experience that people want to have often, which I think is really powerful.

It is the kind of thing that we heard about Chipotle in the early days and it is the kind of thing that obviously drives Chipotle's comps today.

So we are going to focus on those two things right now.

Thank you.

Nicole Miller, Piper Jaffray.

Good afternoon.

In talking about the development you outlined for next year, can you give us a little color on how many are maybe LOIs sign leases where you are accelerating development?

Is it existing markets, new markets, is it international?

And how might it look by quarter?

Thank you so much.

Yes, I think that you are not going to see anything particularly different in next year except for a little uptick in our development as we forecast and going up to a higher number of new restaurants.

But we are still going to have a similar ratio of new markets and proven markets and developing markets.

You won't see much additional work in international.

We have talked about how we are working on -- we talked about how we were working on Germany.

We got that open and we will just be again letting those stores mature.

So you won't see a significant push in international.

Again, there is going to be a few additional ShopHouse restaurants and you won't see a huge push there either.

Because we want to really make sure that those brands are established, that we start to develop awareness, and that we allow them to generate the kind of demand that will cause us to be able to respond by giving more supply.

So I think you will see a lot more of what you see now with a small number of A models.

Again, we will look for as many A models as we can find this year.

It is going to end up being something like 25 for the year.

Next year we would love to see that many again if we can find them.

We are always out trying to find those opportunistic deals.

But again, I think you'll see a very similar ratio of new markets, existing markets, as you did this year, just a little bit more per quarter.

And I think very level loaded, again, as best we can.

We anticipate that they will be quite level loaded next year because the pipeline is very, very healthy right now.

Okay.

It looked like the preopening dollars were just a little tiny bit weighted towards the back part of the year.

So just want to make sure we didn't need to front end load anything in the next year.

But it sounds pretty even.

Yes, the third quarter was pretty high.

We typically have preopening costs in the $75,000 or $80,000 or $85,000 range.

This quarter, I think it was more like $120,000.

That is more a function of we have got a nice pipeline of openings teed up for the fourth quarter.

But those preopening costs, they are incurred.

Most of that is rent.

Most of that preopening cost is rent.

And so because of all of the restaurants we have got under construction that will open up with the fourth quarter, we had a little bit disproportionate amount of the preopening cost hit in the third quarter.

If you look at year to date for the 129 we have opened so far, our preopening cost averaged about $83,000.

And I think that would be more normal.

And so fourth quarter should return to a more normal preopening.

And then next year, yes, as Monty said, we feel like the pipeline has set us up for reasonably level loaded.

Nothing too extreme to expect.

Thank you.

Jeff Farmer, Wells Fargo.

Just looking to follow up a little bit on pricing.

I guess how do you guys generally test a price increase if you are still doing that?

Would a price increase be across most of the menu?

Would it be most of the markets?

How would you guys talk about price increase this time around?

Yes, we don't really test it per se, Jeff.

What we do, though, is we go market by market and we look at competitors and we look at what prices they are charging.

And we will look at it, item by item.

So we will look at sandwiches and burritos and drinks and sides and things like that.

And so we will look at the whole menu.

It is likely that the entire menu will be touched, but we -- well, like, for example if we had an overall average increase of 4%, we might increase some items higher, some items lower, just based on what looks competitive out there in the marketplace.

And then, market by market, we will also look at what consumer demand looks like as well.

If we feel like there is more room to increase based on where our competitors are, in terms of their pricing and we have healthy - comp momentum as well, that might cause us to take that particular market that we are looking at and maybe inch up the price increase a bit there.

And our expectation is that we will have increases in every single market.

Most of our markets by the time we get to the next year, there will be three years that we have had a price increase in any of the markets except for on the West Coast when it would be more than two years.

And so, our expectation would be when we do this, we had a price increase it will be across all markets.

All right, that is helpful and one other quick one.

Coming back to catering a bit.

I think it has been in Denver since the early part of this year, but really I am looking for any color you can provide on the [fields] progression.

You continue to point to approaching 1%, but I didn't know if you started at 20, 30 bps and it has grown to 1% over the summer and then, any other pieces of information you have learned as you have rolled this out into new markets in terms of potentially how to get customers a little bit more on board with the idea of potentially using the catering service.

Yes, Jeff, we are learning a lot about catering and we have not even been through a full season yet.

What we did see, though, is the early summer was a lot bigger than any part of the rest of the year we have seen so far, and that is because of graduations.

And so when we look at catering in markets like Denver that we have had it for the entire year, that was our peak season so far.

We think we might be moving into another peak season now with the holidays.

And Steve mentioned we are going to be doing some advertising around that to encourage people to try it.

The other thing we have seen is that the longer catering is in the market, that that generally -- generally we do see the catering build over time.

Now it is not a straight line because like I said there's seasonality to it where we had a lot more catering in the graduation season in the May and June period.

So it is not a straight line.

But generally, like in a Denver, it started out slower and I would say Denver is higher than average.

So, Monty talked about catering being approaching 1%.

The markets that have had it the longest are a little higher than that.

The markets that have not had it as long are a little lower than that in general.

That is not a perfect formula, but that is generally what we have learned so far.

And we do know that we have to create awareness.

And so, I know that Mark is considering a number of ways in addition to advertising about how we can create more awareness.

What we have found so far is that when our customers get a chance to try the catering, it is a really neat experience.

And they love every bit about it.

They love the control, they love the food, they love the packaging.

They really love everything about it.

And so I know Mark is working on a number of ideas in terms of how to encourage more people to try catering.

Because we think that will help us continue to build the business.

Thank you for that thoughtful response.

John Ivankoe, JPMorgan.

It is Amod filling in for John.

You are very forward thinking on a lot of different things including moving to non-GMO.

I was curious what your thoughts are on development of a stronger mobile app platform and maybe more specifically how you could tie that into throughput.

I know there's some companies out there that have mobile payment for instance and on top of that also layering in loyalty.

Great question.

We are working on it.

We have something that is in what I will call a beta test right now.

We think it has got lots of opportunities right now.

We just want to make sure that the technology works just from a payment standpoint.

If we come up with technology that has any glitches whatsoever, it would kill us from a throughput standpoint.

And so we have to make sure technology is perfect from that standpoint.

And so we are working on that right now.

Once we get that, we do think there's lots of opportunities to communicate with our customers, to speed up throughput, to communicate with our customers on a more customized way.

Customers who haven't been for a while or customers who have never tried guacamole, for example.

You know, there are lots of ways to communicate.

But we are actively working on this and hopefully we will see something in 2014.

And then, can you help us understand the non-GMO supply chain?

I don't think a lot of us are that familiar with it.

I would think that, as you switch over to that, it is obviously a lot of demand probably coming on the market with a company of your size.

So, is the entirety of the potential structural cost increase going to be passed on with the price increase that you take mid -- the middle of next year?

Or should we expect COGS to move up because of that?

Well, we don't know for sure, but right now we don't have many ingredients that have GMO.

And so while it is complicated to change some of our recipes, we have made very, very good progress so far with changing out some of the oils.

We need to work now on our tortillas.

And there is just in some cases small amounts like our flour tortillas, just small amounts of oils in the tortillas that we need to try different recipes with different oils and make sure that the taste is still delicious, that we can still roll the burritos, that they hold up well with our ingredients and things like that.

So we don't have that many GMOs left.

So I wouldn't say that we are going to have this huge demand per se.

So we are hopeful that while it will cost more in our foods, we hope it is not -- I think you were implying that it would be a dramatic increase in our food cost.

We are hopeful that it is not going to be dramatic, that it is manageable in that the menu price increase that we are thinking about would more than cover the inflation we have seen so far and cover the GMO -- the cost of removing the remaining GMOs as well.

That's helpful.

Thank you.

Nick Setyan, Wedbush Securities.

I wanted to ask a bigger picture question around how you guys think about pricing in general.

Is it really just a function of your unique supply chain and the way you source the food?

To what extent do you think about competitive pricing within both fast casual and obviously casual dining category has been a lot more competitive in terms of pricing as well.

To what extent does the competitive pricing come into that decision?

Well, when we think about pricing we already have and have for a long time spent more money on our ingredients as a percentage of sales than our competitors or in fact more than any public company or committee for which we have the records.

So we have high food costs.

And that is not something that troubles us too much as long as we are able to run a very successful unit economic model, which we have been able to do.

Primarily through having really high sales volumes in our restaurants.

So, we do buy more expensive ingredients, but that has been something that we have been doing for quite some time.

And our purchasing department is really, really good at going out and working and finding suppliers who are eager to do or raise animals or grow crops in ways that are consistent with our protocols.

And so they are always working constantly on trying to increase the supply of those ingredients that are available to us so that we can continue to increase the amount of Food With Integrity that we serve in our restaurants.

So, the main thing that governs our thinking about pricing is that we want to continue to make this kind of -- this new way of eating very accessible to people.

So we want to keep our prices low so that our customers continue to enjoy this very different way of eating.

But by the same token we want to still have a very strong unit economic model.

We have been able to do that by virtue of the fact that our food tastes better and we have high average unit volumes enough to cover this more expensive food cost.

Great.

Thank you.

And you mentioned the very strong pipeline in terms of development.

Are you seeing a nice acceleration in new construction?

Is that the key factor in why you are able to up the guidance for next year?

Yes, I think that is only a small part of it, but yes.

The answer is yes.

The amount of new construction has increased.

It has been increasing just incrementally each quarter over the last several quarters.

But it does continue to keep making up more and more of our future portfolio just like it was making up correspondingly less and less of our portfolio after 2008 and 2009.

But, yes, that amount of new construction has ticked up such that it is exceeding 40% of the restaurants that we will see, that will open in the fourth quarter this year and probably a little bit higher than that for next year.

And so, in other words, more than 40% of the restaurants we open next year will come from new construction.

So that amount keeps ticking up gradually as a result of more folks being willing to put their money into building new shopping centers and so forth.

So that is helping us, I think, to find more great real estate.

And lastly, I have been getting a lot of pictures today from friends in LA of your opening of ShopHouse in Santa Monica.

It looks like I can't see the end of that line.

There is a huge line out the door apparently and it goes all the way to the street.

That's great news.

And again, we are really, really excited about ShopHouse.

Not only about the team that we built, but the incredible food and this different kind of food that we are making available to people.

It is an exciting way to eat and it is fun to make this available to people.

Bryan Elliott, Raymond James.

Good afternoon.

Just a point of clarification on the move to non-GMO food.

Do the proteins need to be only fed non-GMO corn?

No.

I mean, right now in order -- if you want animals that have not eaten any GMO, you have to find organic meat.

And so when we talk about GMOs, right now there's really no way to find an adequate supply of animals that have not eaten any crops containing GMO ingredients.

So that is not what we are talking about when we are talking about getting rid of GMOs right now.

Because none of the animals are obviously genetically modified, but animals in this country are eating grains that are often GMO.

Another thing that I mentioned just while you are clarifying that issue is our soft drinks contain high fructose corn syrup, which is a GMO ingredient.

So there is not an effort on our part to eliminate GMOs from soft drinks.

So this is an effort to go through all of our food ingredients and remove GMOs from every single food ingredient that we serve.

Where possible, yes.

Okay.

All right.

Well, I mean, yes, where possible, but we will be able to remove them from all of our food ingredients.

Because again, the -- an animal that eats GMO agreements is not technically a GMO.

It is not a genetically modified organism because the organism is the animal.

All right, I'm sorry, maybe I misunderstood the soft drink comment, then.

So, (multiple speakers).

We are making a distinction between food and drinks, I guess.

I am saying the soft drinks (multiple speakers), yes.

And you really can't get raw sugar, regular cane sugar drinks much in the US anyway, right?

(multiple speakers)

It is something we always are looking at.

It is very difficult to do at this point and certainly not from the mainstream fountain drinks that you would see.

Yes.

Okay.

Thanks.

Steve Anderson, Miller Tabak.

Good afternoon.

A couple of quarters ago you mentioned about having some of the breakdown of new units looking more at food courts as a potential source of unit growth.

Have you given any more thought to that as potentially your unit portfolio?

Yes, we aren't looking more at food courts, per se, but as a part of our continuing expansion of our portfolio, we have found success in a whole bunch of food court settings.

But there's a number of real estate locations that we call nontraditional and in 2013 we had -- we opened 13 food court locations, by way of example.

But it is not that we are looking to increase that, we just are open to considering those kinds of locations as well as airport locations or highway locations.

Even military locations in the future is something we are looking to get more involved with.

So we call all of those nontraditional locations.

If you talked to us five, six, seven, eight years ago, we were very hesitant to get involved with locations like that.

Because it was a time during which we were establishing the Chipotle brand and it was very, very important to us that we did so in a way that represented what we were doing.

But, as the awareness of Chipotle has grown and as the demand for this new way of eating has grown, it has been appropriate, we find, to go into some of those locations to allow folks the Chipotle experience in malls, airports, highway stops, other places that we would not have considered well in that initial brand building stage.

Thank you.

David Tarantino, Robert W. Baird.

Good afternoon.

Jack, just a question to follow up on how you are viewing the food cost ratio.

If I look at how that has trended historically, 33.5% to 34% is as high as it has been in the last 10 years.

And I just want to come back to the question of where you would like to see that food cost ratio long-term.

And specifically where you would like to get it to when you take the price increase at the middle of next year?

Yes, our food cost has generally has ranged between 31% up to around 34%.

It has gotten as high as or close to 34% and that is the range we are talking about right now as a perspective and while my preference would be -- or our preference would be around -- 32% seems to be kind of a sweet spot.

But the food cost isn't as important as what our overall margin is.

And then what our return is.

So, let me give you an example.

Just as a perspective, just on math if you push the math through on a 4% price increase and if you have little or no resistance on that price increase, the food cost will improve by about 130 basis points.

And so 4%, now not considering the cost of GMOs, but just to work through the math here.

So our food cost, which is now in the 33.5% to 34% range, now drops down much closer to that 32% or 32.5% range and so that is nice.

But the margin on a 4% price increase, again, just based on today, not taking other factors into account, would increase by 250 to 260 basis points or so.

So that would put us at all-time high margins and even if there is more inflation and even with covering the cost of GMOs, there is a lot of room there for our overall margin to be at record levels.

It would give us the opportunity to have returns that are at or above what our record levels have been and our returns have been in the 65% to 70% cash on cash return range.

So when I think about the pieces and when I think about the inflation that has happened and is about to happen, when I think about the costs of GMOs and I think about our pricing power, which we believe and everyone who has tried to go out there and either prove or disprove whether we have pricing power either by surveying customers or by comparing us to competitors, just confirms that we have pricing power, I feel like a mid single digit inflation will do everything we need to do.

And if our food cost ends up being closer to 33% than 32% or so, but our margins end up being at or above where they have ever been, that would be just a fine result as far as we are concerned.

Great.

That is really helpful.

And then I guess on the inflation outlook for next year, you mentioned it being pretty tame.

I guess with the corn prices where they are, what are the chances you might see some favorability on the food cost themselves as you move into maybe the second part of next year?

Well, what that might affect, David, it would affect the prices of our meats if corn continues to be favorable.

I don't know that it would -- we are not predicting at least or nothing we are seeing is predicting that costs will go down, but if they hold at this level that would be great.

We buy white corn for our salsas.

And so that is more expensive already.

And so we are not seeing that that is going to go down.

But certainly we would welcome if the feed prices do decline and if that causes our meat prices to relax a little bit, that would be welcome.

But right now we are seeing more of a tame-ish environment, not a deflationary environment.

Thank you very much.

All right, thanks, everyone.

It looks like we have lapsed our time, but we thank you for joining us today and we look forward to speaking with you next quarter.

Thanks, everyone.

Thanks, everyone.

Thank you.

This does conclude our conference.

You may now disconnect.